Bitcoin and Blockchain Technology: Hayek Money

Bitcoin and Blockchain Technology
The Cryptocurrency Frontier in Commodity Monetary Standard
ferdinando@ametrano.net
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Table of Contents
1. Bitcoin, Money, and Gold
2. Hayek Money
3. Dual Asset Ledger & Reserve Asset Bank
Ferdinando Ametrano 2017 2/55

Understanding Lags Well Behind the Hype
Understanding of the technology however lags well
behind the hype, amongst practitioners, policy makers
and industry commentators alike. ‘Blockchain’
technology seems to promise major change for capital
markets and other financial services – some say it may
ultimately prove to be as important an innovation as the
internet itself – but few can say exactly how or why.
Michael Mainelli, Alistair Milne (2016)
The Impact and Potential of Blockchain on the Securities Transaction Lifecycle
http://ssrn.com/abstract=2777404

Why Bitcoin Is Hard to Understand
At the crossroads of:
1. Cryptography
2. Distributed systems (networking and data transmission)
3. Game theory
4. Economic and monetary theory
Mainly not a technology,
a cultural paradigm shift instead

• Decentralized digital currency
• Not backed by any government or organization
• Instantaneous peer-to-peer transactions
• No need for trusted third party
• Cryptographic security
• Synergic economic incentives
• Efficient low-cost banking for everybody everywhere
https://bitcoin.org/en/faq
http://www.coindesk.com/information/

The Information Economy
• Data is transferred with zero marginal cost
• Why pay a fee to move bytes representing wealth?
• Why only 9-5, Monday-Friday, two days settlement?
• Who (and when) will gift humanity with a global
instantaneous free p2p payment network?
BANK

Bitcoin
• Decentralized: no central authority, no intermediaries
• Permissionless: no regulator
• Censorship resistant: no frozen funds
• Open-access: no discrimination, no amount limits, 24/7, 365 days
• Free: negligible transaction costs
• Borderless: no geographic limits
• Transnational: no specific jurisdiction applies
• Secure: non falsifiable, non repudiable transactions
• Resilient: nothing has been able to stop it or break it

A Bitcoin Transaction
https://blockchain.info/tx/8f1d3a8ef6b2d4a25d2f499279e01518b4770819ccbc39a765c4c326170c61b3
About $83M transacted with $0.04 fee

BTC/USD Exchange Rate
http://bitcoincharts.com/charts/bitstampUSD#tgWzm1g10zm2g25
• BTC Market Cap: about $50B (USD M0 1959-2017 average has been $680B)

Double Spending Problem
• To securely transfer value using digital means has
been possible for decades
• In digital cash schemes, a single digital token,
being just a file that can be duplicated, can be
spent twice
• A centralized trusted party has always been
required to prevent double spending

Mining
• All bitcoin network nodes validate and propagate transactions
• Transactions are cleared in blocks, thus a blockchain: the nodes
providing computational power for clearing are called miners
• Miners compete to validate a new block of transactions: the winner
providing proof-of-work is rewarded with the issue of new bitcoins in
a special coinbase transaction included in the block
• Miners solve the double spending problem:
– conflicting transactions spending the same coins would invalidate the block
– an invalid block would be rejected from the network
– the bitcoin reward would be removed from transaction history
– miner would have wasted his workFerdinando Ametrano 2017 11/55

Distributed Consensus
• How do miners reach consensus on the
transaction history?
• Consensus in an asynchronous network with faulty
(or malicious) nodes is proved to be impossible
• A problem known as Byzantine General Problem

Nakamoto Consensus
• Nakamoto achieves Practical Byzantine Fault Tolerant consensus
using (game theory) economic incentive for the mining nodes to be
honest. Bitcoin
– solves double spending without a central trusted party
– can resist attacks of malicious agents, as long as they do not control
network majority
• Miners are compensated for their proof-of-work using seigniorage
revenues, i.e. with issuance of new bitcoins
• Seigniorage revenues subsidize the network, making transaction
almost free

Network Costs Covered By Seigniorage Revenues
• 144 blocks per day, 365 days per year
• 12.5 BTC per block, $6,000 per BTC
Currently about $4 billions per year (as of November 2017)

Virtuous Cycle
Hashing
Power
Bitcoin
Security
Bitcoin
Price
Mining
Reward

Validation Process: Block Generation
The proof-of-work difficulty is adapted to the overall available computing
power to ensure an average of one block every ten minutes

Bitcoin Monetary Rule
• 2009: 50BTC per block, every 10 minutes
–halving every 4Y
• This is the only way new bitcoins are released
• It is called mining because of its similarity with the
progressive scarcity of gold extraction
• Supply free of discretionary intervention

Bitcoin Inelastic Supply:
Deterministic Decreasing Rate
chart
2029: 96.88% of
all BTC issued
2141: last satoshi
(0.00000001 BTC)
will be issued

What after 2141?
• We are all dead ;-)
• Gradually switch over to a fee-based system: as block space is
limited, market is already requiring a growing satoshi/byte fee
to be included into a block
• Switch to a different paradigm? We have about 120 years to
come up with a solution

What Makes Bitcoin Special?
• Digital and scriptural: it only exists as validated transaction
• Asset, not liability
• Bearer instrument
• It can be transferred but not duplicated
(i.e. it can be spent, but not double-spent)
• Scarce in digital realm, as nothing else before
• Mimicking gold monetary policy
• More a crypto-commodity then a cryptocurrency
Bitcoin is digital gold
this is the brilliant groundbreaking achievement by Satoshi Nakamoto

Trade Economy
From Gold Standard to Fiat Money
• Gold: the commodity money standard
– scarce
– pleasant color, i.e. resistant to corrosion and oxidation
– high malleability
– relative easiness of its purity assessment
• Gold purity certification
• Representative money
• Fractional receipt money
• Fiat money and legal tender

Money As A Social Relation Instrument
1. Human beings are born into a gift economy
2. Enlarged relationship circle requires exchange
economy
3. Barter economy: coincidence of wants
4. Trade economy: money as medium of exchange
5. Global information economy: supranational digital
money

Friedrich August von Hayek
Denationalisation of Money
• history of coinage is an almost uninterrupted story of debasements;
history is largely a history of inflation engineered by governments for
their gain
• why government monopoly of the provision of money is regarded as
indispensable? It deprived public of the opportunity to discover and use
a better reliable money
Blessed will be the day when it will no longer be from the benevolence of
the government that we expect good money but from the regard of the
banks for their own interest
A Free-Market Monetary System, Gold and Monetary Conference, New Orleans, Nov. 1977, https://mises.org/daily/3204
Hayek, F. A., Denationalisation of Money, The Institute of Economic Affairs, http://www.mises.org/books/denationalisation.pdf

Permissionless Innovation
Fast and Effective
• No centralized security mechanism, no barrier to
enter, no editorial control
–Email has not been designed by a consortium of postal
agencies
–Internet has not been developed by a consortium of telcos
• Will a decentralized transactional economy be shaped
by a consortium of banks?

Explain Money to an Alien
fiat money
• No intrinsic value (legal
tender, social contract)
• Currency based on paper/ink
security
• Discretionary governance
• Wicksellian interest-rate
approach
bitcoin
• No intrinsic value (digital
gold)
• Currency based on
math/cryptographic security
• Algorithmic governance
• Deterministic supply

Bitcoin as (Digital) Gold
in the History of (Crypto)Money
gold
• Its adoption was not centrally
planned
• For centuries it has been the most
successful form of money
• It has bootstrapped all monetary
systems we know of
• It has been surpassed by other kind
of money without becoming
obsolete
bitcoin
• Its adoption has not been centrally
planned
• It is the most successful form of
cryptocurrency
• It will bootstrap new monetary
systems
• It might be surpassed by more
advanced type of cryptocurrencies
without becoming obsolete

Table of Contents
2. Hayek Money

Unit of Account: Money as Numeraire
• Money is the unit of account against which the value of
every other good is measured
• The price system measures the value of goods relative
to the value of money
Good money should provide stable prices to best perform
its role as unit of account

Money Comparison
Medium of Exchange Store of Constant Value Unit of Account
Live cattle
Diamonds
Gold
Fiat coins and notes
Bitcoin
• swappable
• fungible
• portable
• divisible
• recognizable
• resistant to
counterfeiting
• reliably saved, stored,
and retrieved
• retain usefulness over
time
• Maintain its storage
properties
• non-perishable or with
low preservation cost
• relative worth unit of
measure
• stable value for stable
price comparison
• supply must be
controlled in some
way

The Holy Grail of Stable Prices
• Gold standard, bimetallism, symmetallism
• Fixed value of bullion (Aneurin Williams 1892)
• Compensated dollar (1911-20 Irving Fisher)
• Commodity Reserve Currency (1932 J. Goudriaan, 1937-44 B.
Graham, 1942 F. Graham, 1951 M. Friedman)
• ANCAP basket (1982 Robert Hall)
• Futures contracts (1984 Miles, 1989-95 Sumner)
• Quasi-futures contract (1994 Kevin Dowd)
• Price index option (2000 Kevin Dowd)

Bitcoin is Digital Gold
Not a Good Unit of Account
• no salaries, no
mortgages, no stable
purchasing power
• successful at getting rid
of a centralized
monetary authority, it
has given up the
flexibility of an elastic
supply of money

Hayek Money
• The cryptocurrency monetary standard of elastic
non-discretionary supply
• Price stability paradigm with respect to a given
reference basket
• Concurrent cryptocurrencies will compete in
monetary policy definition and reference basket
choices

Fixed USD Exchange Rate
• USD/BTC: 15-Apr-11 1.0, 29-Mar-14 500.0
• x500 increase for BTC demand relative to USD
• 29-March-14: 12.5M bitcoins in circulation
• Inflate their number 500 times to 6250M
• On 29-Mar-14 it would have been equivalent
–to own BTC1 worth $500
–or (rebased) RBTC500 each worth $1

USD-Parity (Daily) Rebased Bitcoin
• Adopting the USD Consumer Price Index
• 6% inflation in the period March 2011-2014
1.06

Avoid USD Monetary Policy:
Brent-Wheat Commodity Price Index

Rebased Bitcoin

Rebasing Bitcoin?
No, not really!
• Bitcoin has been used for the sake of discussion,
basically to leverage its historic price time series
• Bitcoin is good as it is: more of a cryptocommodity
than a cryptocurrency, bitcoin is digital gold

Hayek Money
This First Simplistic Implementation
• Results:
– Price stability
– Salaries, mortgages, forward payments are now possible
• Problems:
– Number of coins in a wallet changes without direct in/out flows
– Purchasing power of a given wallet is not stable
– Coins still have speculative investment appeal and so enjoy limited
transaction usage

Table of Contents
2. Hayek Money

Hayek Money Implemented as
Dual Asset Ledger
Split transactional and speculative money demand with
two non-fungible assets:
• (stable) transactional coins
• (unstable) speculative shares
Blockchain technology tracks ownership and transactions
for both: dual asset ledger

Reserve Asset Bank IPO
• Raise bitcoins as reserve asset in 𝑅𝑒𝑠𝐴𝑠𝑠 quantity
Better to avoid non-crypto reserve assets: a custodian legal entity would
be required, re-introducing centralization
• Issue 𝐶 coins and 𝑆 shares
Monetary base is backed by 𝑅𝑒𝑠𝐴𝑠𝑠:
𝐶 ∙ 𝑃𝐶 + 𝑆 ∙ 𝑃𝑆 = 𝑅𝑒𝑠𝐴𝑠𝑠

Monetary Policy Target
Coin is pegged to a given reference basket for price parity:
𝑃𝐶 ≅ 1, allowing for a corridor, e.g. 0.95 < 𝑃𝐶 < 1.05
• Must be 𝐶 ≪ 𝑅𝑒𝑠𝐴𝑠𝑠 at IPO
• Hopefully 𝐶 < 𝑅𝑒𝑠𝐴𝑠𝑠 any time later on
The Reserve Asset Bank (even as Decentralized Autonomous
Organization) enforces price boundaries by market operations using
reserve assets

Monetary Phases
Expansionary monetary phases (when 𝑃𝐶 ↑ 1.05):
• new coins are minted by the Reserve Asset Bank and sold for
1.05 in exchange for bitcoin (increasing reserves)
Contractionary monetary phases (when 𝑃𝐶 ↓ 0.95):
• existing coins are bought at 0.95 (and destroyed) by the
Reserve Asset Bank using bitcoin (until reserves are depleted)

Reserve Asset Bank: Stable Coins
• When 𝑃𝐶 ≅ 1, coins give up any speculative value
• Money velocity and transaction volume increase
𝑀𝑉 = 𝑃𝑇
M is the money supply (total amount of money in circulation;
V is the velocity of money for all transactions in a given time frame;
P is the price level;
T is the aggregate real value of transactions in a given time frame.
• Coins should not be inflated/deflated arbitrarily
• Transaction validation must be rewarded with the
issuance of new shares, not coins

Reserve Asset Bank: Seigniorage Shares
Seigniorage: profit made by a currency issuer, especially the difference between the face value of coins
and notes and their production costs
• Shares are never burned/destroyed
• Shareholders are in charge of reference basket maintenance
• The share price is free to float: shareholders absorb all monetary
policy’s costs and benefits, shielding coin holders from volatility
• Share value = assets - liabilities
𝑆 ∙ 𝑃𝑆 = 𝑅𝑒𝑠𝐴𝑠𝑠 − 𝐶 ∙ 0.95

𝑃𝐶 ↓ 0.95: Losses for Shareholders
𝑆 ∙ 𝑃𝑆 = 𝑅𝑒𝑠𝐴𝑠𝑠 − 𝐶 ∙ 0.95
• If 𝑃𝐶 ↓ 0.95 and 𝑅𝑒𝑠𝐴𝑠𝑠 < 𝐶 ∙ 0.95:
coin is dead, Reserve Bank defaulted, 𝑃𝑆 = 0
• If 𝑃𝐶 ↓ 0.95 and 𝑅𝑒𝑠𝐴𝑠𝑠 > 𝐶 ∙ 0.95:
coin is dead, Reserve Bank has not defaulted, 𝑃𝑆 > 0
(no interest for stable coins, shares are the equivalent
of bitcoins)

𝑃𝐶↑ 1.05: Profits for Shareholders
• fresh new coins are minted and sold in exchange for
reserve assets pushing 𝑃𝐶 down to parity
• Reserve assets increase by 1.05
• Coin liabilities increase by 0.95
• Net effect: 𝑃𝑆 ↑

Leverage Bitcoin As Reserve Asset
• Bitcoin is the first and most successful instance of an intrinsically
scarce digital asset: it’s digital gold
• When used as reserve asset, its qualities are magnified!
• Its limits are lessened. No more need to:
– scale to huge (cash + bank accounts + credit cards) number of transactions
– support economically inefficient micropayments
– lower confirmation time
• The Reserve Bank IPO raises bitcoins, issues seigniorage shares and
stable coins

The Ultimate Fate of Bitcoin:
To Serve as a Reserve Currency
https://bitcointalk.org/index.php?topic=2500.msg34211#msg34211
Hal Finney (1956–2014) was a noted cryptographic activist. He was the second PGP Corporation developer hired after Phil
Zimmermann. He created the first reusable proof-of-work. He was an early bitcoin user and received the first bitcoin
transaction from bitcoin's creator Satoshi Nakamoto.

Transaction Validation
Proof-of-Payment
• Instead of the hardware and electric power expenses of proof-of-
work, bitcoins are irrevocably paid to the Reserve Asset Bank by
validating nodes (proof-of-payment)
• Chances of being appointed for the next block generation are
proportional to the overall submitted payments, i.e. to the
accumulated proof-of-payment
• When a node is picked up for block generation its proof-of-
payment resets to zero
• Even if a node is not picked up, its payments are never reimbursed

Transaction Validation
Proof-of-Payment
• Block generation is rewarded with the issuance of a new
share
• Since 𝑃𝑆 = 𝑅𝑒𝑠𝐴𝑠𝑠 − 𝐶 ∙ 0.95 𝑆, that should be the
price a rational agent is willing to commit as payment
• Share price estimation in bitcoin is obtained as by-product
• Existing shareholders are not really diluted: for the issuance
of each new share, 𝑅𝑒𝑠𝐴𝑠𝑠 increases accordingly

Bibliography
• Ametrano F., Hayek Money: the Cryptocurrency Price Stability Solution,
http://ssrn.com/abstract=2425270
• Morini M., Inv/Sav Wallets and the Role of Financial Intermediaries in a
Digital Currency, http://ssrn.com/abstract=2458890
• Sams R., A Note on Cryptocurrency Stabilisation: Seigniorage Shares,
https://github.com/rmsams/stablecoins/blob/master/00-main.pdf
• Buterin V., The Search for a Stable Cryptocurrency,
https://blog.ethereum.org/2014/11/11/search-stable-cryptocurrency/
• Ametrano F., Cryptocurrency Price Stability With Seigniorage Shares And
Reserve Bank, http://ssrn.com/abstract=2508296

Bibliography
F. Ametrano, Bitcoin, Blockchain and Distributed Ledger
Technology: Hype or Reality? (2017)
https://goo.gl/Z9OeHt
Bitcoin and Blockchain Technology videos (ITA):
• Introduzione
https://www.youtube.com/watch?v=Ef3d1N4Ogxw&list=PLrVvuryXHYTdzvtpzrj4wvYEhCwF6G82b&index=1
• Hayek Money
https://www.youtube.com/watch?v=Wu_7RVwoV84&list=PLrVvuryXHYTdzvtpzrj4wvYEhCwF6G82b&index=2
• Distributed Ledger Technology
https://www.youtube.com/watch?v=ByzoYHx7eTc&list=PLrVvuryXHYTdzvtpzrj4wvYEhCwF6G82b&index=3

Conclusions
1. Bitcoin solves the double spending problem relying on seigniorage
revenues
2. Bitcoin is a scarce digital asset, i.e. the digital equivalent of gold
3. Hayek Money is the price stability paradigm of elastic non-
discretionary money supply
4. Coin/share dual asset ledger can decouple transactional and
speculative money demand
5. Bitcoin can be used as reserve asset by a decentralized Reserve
Asset Bank (DAO) to stabilize the coin
6. Proof-of-Payment leverages bitcoin as off-chain resource to be
consumed in order to receive seigniorage revenues

Bitcoin and Blockchain Technology: Hayek Money

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